Dude, Where’s my Inflation?

It is often held as conventional wisdom that expanding the money supply means causing inflation. Those claiming this say that “printing” more money will automatically increase the prices of goods and services in an economy. In the view of many, the expansion of the money supply somehow bypasses the forces of supply and demand and increases prices. Yet, we have seen a tremendous expansion of the U.S. money supply since the global crisis of capitalism in 07-08.

09-04 Fed Balance

As we can recall from recent history, there has been no Zimbabwe-style hyperinflation. In fact, in the years after the crisis inflation has remained at historical lows of around 2.5%. Since the Federal Reserve increases the money supply so great, why hasn’t this classical and Austrian predicted out of control inflation occurred?

The reason is that the economy is in a liquidity trap. This means all of the expanded money is not being put out into the economy regardless of the low-interest rates dictated. That money remains in the Fed reserves of the individual banks.

Had this money been sent out into the economy and used, it would have been a different case. The loaning out of excessive amounts of money leads to a drastic increase in demand for goods and services. This increased demand is what causes prices to go up. This is how an expansion of the money supply causes inflation – only by the utilization of the money stimulating demand. If there is no massive expansion of the economy, there is no inflation. The money remains in the reserves of the banks at the Fed.

At this point, some might ask: So what is the point of expanding the money supply? The primary purpose was to shore up the reserves of banks in the event of another run on them. This would essentially prevent the reoccurrence of another Great Depression-style situation. The second aspect of it was the Fed entering the market for commercial paper. These are the small loans that small and large businesses use to keep afloat during rough periods.  It also made loans available for new business while the banks themselves were refusing to loan. Given this, it’s very likely that the expansion of the money supply and the corresponding monetary policy actually prevented the crisis from becoming worse.

This is a far crime from the doomsday scenarios that were being touted, most notably, by Austrian economists who predicted the end of Western civilization if the money supply was expanded.